Informed Options Trading prior to M&A Announcements: Insider Trading?

Informed Options Trading prior to M&A Announcements: Insider Trading? Patrick Augustin McGill University-Desautels Faculty of Management Menachem Brenner New York University-Leonard N. Stern School of Business Marti G. Subrahmanyam New York University-Leonard N. Stern School of Business Columbia University/Bloomberg Machine Learning in Finance Workshop New York March 6, 2015

Motivation Unusual Options Trades before M&As 14Feb2013: H.J. Heinz by Berkshire Hathaway and 3G Capital Market Price 13 Feb: $60.48. Purchase of 2,533 Jun $65 OTM calls (13 Feb). Offer Price 14 Feb: $72.50. Total Profit: $1.8 million. 14Jan2004: Bank One Corp. by JP Morgan Market Price 14 Jan: $45. Purchase 2,750 Jan $47.5 OTM calls (14 Jan, 1h before announcement). Offer Price 14 Jan: $51.77. Total Profit: $0.825 million. More Insider Trading Cases Are these isolated cases? Are there many cases that go undetected? Marti G. Subrahmanyam Informed Options Trading prior to M&A Announcements: Insider Trading? 2 / 50

A Striking Example: NEXEN Takeover by CNOOC Total OptionsVolume (# Contracts, Calls and Puts) 0 10000 20000 30000 40000 Total Daily Options Trading Volume in Nexen Takeover Bid Deal Announcement: 23 July Unusual Trading Volume 20 July 16/17 July 06may2012 13may2012 20may2012 27may2012 03jun2012 10jun2012 17jun2012 24jun2012 01jul2012 08jul2012 15jul2012 22jul2012 29jul2012 05aug2012 12aug2012 SEC reacted because of suspicious stock trading! Marti G. Subrahmanyam Informed Options Trading prior to M&A Announcements: Insider Trading? 3 / 50

Why do we care? SEC Enforcement Program for Insider Trading: a high priority area for the SEC. 0 10 20 30 40 50 60 70 42 50 46 47 2 3 4 2 61 11 37 8 53 57 58 13 12 6 44 9 FY2004 FY2005 FY2006 FY2007 FY2008 FY2009 FY2010 FY2011 FY2012 FY2013 Total SEC Enforcement Actions Options and M&A Enforcement Actions We focus on insider trading in options ahead of M&As 5 cases per year on average (1995-2013). SEC Statement Definition of Insider Trading Marti G. Subrahmanyam Informed Options Trading prior to M&A Announcements: Insider Trading? 4 / 50

Outline Motivation Research Question and Hypotheses Data Empirical Analysis Informed vs. Insider Trading SEC Litigation Reports Acquirer Conclusion Marti G. Subrahmanyam Informed Options Trading prior to M&A Announcements: Insider Trading? 5 / 50

Research Question 1. Can we identify and quantify unusual options trading prior to M&As? Random noise or systematic evidence of informed trading in the options market. 2. If yes, where and how do informed investors trade options? Systematic patterns? We focus on trading strategies that someone with private information could exploit to earn abnormal returns as well as the associated effects for prices and liquidity. Forensic Analysis along 3 dimensions. Volume Prices Liquidity 3. How does unusual options activity relate to the characteristics of SEC litigations. Marti G. Subrahmanyam Informed Options Trading prior to M&A Announcements: Insider Trading? 6 / 50

Research Design Options trading before M&As is a useful laboratory to study informed trading. 1. M&As are the closest we can get to unexpected corporate announcements. Jump in price of Target (31% premium, 16% abnormal return, on average) and volatility of Acquirer. Assumption: Informed traders are capital constrained. Pre-event activity should be similar to that on random dates. 2. M&As occur frequently enough to construct a meaningful sample. 3. Nature of private information is clearly identified. Rise in target s stock price and flat acquirer stock price. We can formulate clear hypotheses to accept or refute pervasive informed trading. Target (directional) & Acquirer (Volatility). 4. Rich options data allows for the formulation of hypotheses along multiple dimensions. Multiple strike prices. Multiple expiration dates. Marti G. Subrahmanyam Informed Options Trading prior to M&A Announcements: Insider Trading? 7 / 50

Hypotheses... before M&A announcements... Targets 1. Abnormal trading volume in equity options. 2. Higher ratio of the abnormal trading volume in (a) OTM call options compared to ATM and ITM call options. (b) ITM put options compared to ATM and OTM put options. (c) Short-dated front options compared to long-dated options. Trading Strategies 3. Excess Implied Volatility. 4. Increase in %Bid-Ask Spread. 5. Increase of the (right) skewness of the option smile/skew. 6. Decrease of the term structure of implied volatility. Acquirers 7. Volume increase in jump-based (long-gamma) trading strategies. (a) Stronger effects for CASH deals. Marti G. Subrahmanyam Informed Options Trading prior to M&A Announcements: Insider Trading? 8 / 50

Literature Literature Details Insider Trading (IT) (other than by corporate insiders/edgar filings) Literature debates whether unusual options activity is random noise... Poteshman (JB2006)....or focuses primarily on stocks... Keown and Pinkerton (JF1981), Meulbroek (JF1992), Frino et al. (IRF2013)....or options around other events: 9/11, LBOs, specific companies... Poteshman (JB2006), Acharya and Johnson (JFE2010), Chesney et al. (WP2011)....or is limited in the depth and scope of the analysis. Wang (JEB2013). Informed Trading in Options around M&A Literature focuses on information content of volume or prices for future stock returns/cars around M&As, focusing on either the target or the acquirer. Cao et al. (JB 2005), Chan et al. (JFQA 2013)....or investigates the predictive power of volume/price measures for stock returns. Hu (JFE 2013), Jin et al. (JAR 2012), Johnson and So (JFE 2011), Pan and Poteshman (RFS 2006)... Our Contribution We document statistical anomalies consistent with trading by informed investors. Unusual, pervasive and non-random options activity before M&A announcements. We conduct a forensic analysis of options activity ahead of M&A announcements. Volume, Prices, Liquidity (IV, Term Structure, Skewness). We quantify randomness of unusual trading. We relate characteristics of unusual trading to SEC litigation reports. We distinguish between informed vs. insider trading. Marti G. Subrahmanyam Informed Options Trading prior to M&A Announcements: Insider Trading? 9 / 50

Data - 1,859 M&A Deals from Jan 1996 to Dec 2012 1. Thomson Reuters SDC Platinum (U.S. M&As) Data filters used: Acquirer seeks to own 50% ex-post, owns 50% ex-ante. Exclude pending & unknown status deals. Deal Value $1 million (exclude small deals). 2. CRSP Minimum of 90 days of stock price/volume info. for target. Keep data up to one year before and after the event. 3. OptionMetrics Jan. 1996 - Dec. 2012 = Sample Period. Minimum of 90 days of option price/volume info. for target. All options that expire after (before) the Announcement Date (iff they are ATM). Keep data up to one year before and after the event. 4. SEC Civil Litigation Reports (and DoJ Criminal Litigation Reports, under revision) All civil (criminal) litigations involving options trading and M&As. Information hand collected from SEC (DoJ) web site. 5. RavenPack News Analytics Global News Database used in quantitative and algorithmic trading. Examines over 19,000 traditional and social media sites, from Jan. 2000 - Aug. 2012 6. Thomson Reuters Insider Filings Table 2: Derivative transactions and holdings by corporate insiders. Examine transactions filed on Form 4 over 365 days before the announcements. 7. COMPUSTAT Detailed balance sheet used to construct propensity-matched control samples. Marti G. Subrahmanyam Informed Options Trading prior to M&A Announcements: Insider Trading? 10 / 50

Sample Characteristics 1859 M&As, 1279 unique acquirers, 1669 unique targets. Subsample of 792: option information on targets only. Panel A: Deal Information Offer Structure Cash Only Shares Total Description No. % of Tot. No. % of Tot. No. % of Tot. Nbr. of Deals 903 48.6% 403 21.7% 1,859 100.0% Completed Deals 746 40.1% 339 18.2% 1,542 82.9% Hostile Deals 35 1.9% 7 0.4% 63 3.4% Same Industry Deals 379 42.0% 268 66.5% 993 53.4% Challenged Deals 111 6.0% 32 1.7% 216 11.6% Competing Bidder 83 4.5% 20 1.1% 142 7.6% Collar Deal 4 0.2% 52 2.8% 120 6.5% Termination Fee 698 37.5% 292 15.7% 1,422 76.5% Bidder has a toehold 42 2.3% 7 0.4% 65 3.5% Panel B: Deal Financials Offer Structure Cash Only Shares Total Description Mean Sd Mean Sd Mean Sd DVal (mil) $2,242.0 $4,147.2 $5,429.8 $15,158.5 $3,848.4 $9,401.3 P1d 33.6% 31.7% 28.3% 39.5% 31.0% 33.1% P1w 36.6% 31.0% 33.6% 61.5% 34.7% 39.8% P4w 41.1% 35.6% 36.7% 45.3% 38.3% 37.7% Cash deals - acquisition price is clear. Average Deal Size is $3.8 billion. Cash deals typically smaller. Average 1-day Offer Premium is 31%. Deal Size Distribution Marti G. Subrahmanyam Informed Options Trading prior to M&A Announcements: Insider Trading? 11 / 50

Sample Characteristics 1859 M&As, 1279 unique acquirers, 1669 unique targets. Subsample of 792: option information on targets only. Panel A: Deal Information Offer Structure Cash Only Shares Total Description No. % of Tot. No. % of Tot. No. % of Tot. Nbr. of Deals 903 48.6% 403 21.7% 1,859 100.0% Completed Deals 746 40.1% 339 18.2% 1,542 82.9% Hostile Deals 35 1.9% 7 0.4% 63 3.4% Same Industry Deals 379 42.0% 268 66.5% 993 53.4% Challenged Deals 111 6.0% 32 1.7% 216 11.6% Competing Bidder 83 4.5% 20 1.1% 142 7.6% Collar Deal 4 0.2% 52 2.8% 120 6.5% Termination Fee 698 37.5% 292 15.7% 1,422 76.5% Bidder has a toehold 42 2.3% 7 0.4% 65 3.5% Panel B: Deal Financials Offer Structure Cash Only Shares Total Description Mean Sd Mean Sd Mean Sd DVal (mil) $2,242.0 $4,147.2 $5,429.8 $15,158.5 $3,848.4 $9,401.3 P1d 33.6% 31.7% 28.3% 39.5% 31.0% 33.1% P1w 36.6% 31.0% 33.6% 61.5% 34.7% 39.8% P4w 41.1% 35.6% 36.7% 45.3% 38.3% 37.7% Cash deals - acquisition price is clear. Average Deal Size is $3.8 billion. Cash deals typically smaller. Average 1-day Offer Premium is 31%. Deal Size Distribution Marti G. Subrahmanyam Informed Options Trading prior to M&A Announcements: Insider Trading? 11 / 50

Sample Characteristics 1859 M&As, 1279 unique acquirers, 1669 unique targets. Subsample of 792: option information on targets only. Panel A: Deal Information Offer Structure Cash Only Shares Total Description No. % of Tot. No. % of Tot. No. % of Tot. Nbr. of Deals 903 48.6% 403 21.7% 1,859 100.0% Completed Deals 746 40.1% 339 18.2% 1,542 82.9% Hostile Deals 35 1.9% 7 0.4% 63 3.4% Same Industry Deals 379 42.0% 268 66.5% 993 53.4% Challenged Deals 111 6.0% 32 1.7% 216 11.6% Competing Bidder 83 4.5% 20 1.1% 142 7.6% Collar Deal 4 0.2% 52 2.8% 120 6.5% Termination Fee 698 37.5% 292 15.7% 1,422 76.5% Bidder has a toehold 42 2.3% 7 0.4% 65 3.5% Panel B: Deal Financials Offer Structure Cash Only Shares Total Description Mean Sd Mean Sd Mean Sd DVal (mil) $2,242.0 $4,147.2 $5,429.8 $15,158.5 $3,848.4 $9,401.3 P1d 33.6% 31.7% 28.3% 39.5% 31.0% 33.1% P1w 36.6% 31.0% 33.6% 61.5% 34.7% 39.8% P4w 41.1% 35.6% 36.7% 45.3% 38.3% 37.7% Cash deals - acquisition price is clear. Average Deal Size is $3.8 billion. Cash deals typically smaller. Average 1-day Offer Premium is 31%. Deal Size Distribution Marti G. Subrahmanyam Informed Options Trading prior to M&A Announcements: Insider Trading? 11 / 50

Sample Characteristics 1859 M&As, 1279 unique acquirers, 1669 unique targets. Subsample of 792: option information on targets only. Panel A: Deal Information Offer Structure Cash Only Shares Total Description No. % of Tot. No. % of Tot. No. % of Tot. Nbr. of Deals 903 48.6% 403 21.7% 1,859 100.0% Completed Deals 746 40.1% 339 18.2% 1,542 82.9% Hostile Deals 35 1.9% 7 0.4% 63 3.4% Same Industry Deals 379 42.0% 268 66.5% 993 53.4% Challenged Deals 111 6.0% 32 1.7% 216 11.6% Competing Bidder 83 4.5% 20 1.1% 142 7.6% Collar Deal 4 0.2% 52 2.8% 120 6.5% Termination Fee 698 37.5% 292 15.7% 1,422 76.5% Bidder has a toehold 42 2.3% 7 0.4% 65 3.5% Panel B: Deal Financials Offer Structure Cash Only Shares Total Description Mean Sd Mean Sd Mean Sd DVal (mil) $2,242.0 $4,147.2 $5,429.8 $15,158.5 $3,848.4 $9,401.3 P1d 33.6% 31.7% 28.3% 39.5% 31.0% 33.1% P1w 36.6% 31.0% 33.6% 61.5% 34.7% 39.8% P4w 41.1% 35.6% 36.7% 45.3% 38.3% 37.7% Cash deals - acquisition price is clear. Average Deal Size is $3.8 billion. Cash deals typically smaller. Average 1-day Offer Premium is 31%. Deal Size Distribution Marti G. Subrahmanyam Informed Options Trading prior to M&A Announcements: Insider Trading? 11 / 50

Options Trading Volume Marti G. Subrahmanyam Informed Options Trading prior to M&A Announcements: Insider Trading? 12 / 50

Options Trading Target - Summary Statistics Higher Trading Volume in short-term and medium-term options. Higher Trading Volume in OTM and ITM options. Contrary to the usual pattern of ATM dominance in volume. Target (N = 2,214,260) DITM Mean SD Min Med p75 p90 Max Panel A: All options, TTE = [0,30] DOTM (3%) 246 1,973 1 20 76 300 94,177 OTM (5%) 370 1,990 1 41 164 596 88,086 ATM (79%) 273 1,291 1 40 152 531 231,204 ITM (5%) 356 6,214 1 20 80 333 539,482 DITM (5%) 275 3,264 1 10 40 171 200,000 Total (100%) 283 2,135 1 35 138 500 539,482 Panel B: All options, TTE = ]30,60] DOTM (6%) 163 863 1 20 63 229 29,045 OTM (9%) 285 1,201 1 32 128 500 55,222 ATM (71%) 184 855 1 25 95 328 71,822 ITM (6%) 190 3,244 1 20 65 254 475,513 DITM (6%) 208 5,288 1 10 37 137 523,053 Total (100%) 194 1,787 1 23 90 316 523,053 Acquirer Statistics Marti G. Subrahmanyam Informed Options Trading prior to M&A Announcements: Insider Trading? 13 / 50

Abnormal Trading Volume - Event Study Event Study over the 30 days preceding M&A announcements. 26% of deals have abnormal volume in calls. 15% of deals have abnormal volume in puts. Abnormal volume higher for OTM calls. Abnormal volume for ITM Puts? - Weaker evidence. Abnormal volume greater for CASH than for STOCK deals. Figure Cash vs. Stock Average Abnormal Volume (# Contracts) 0 500 1000 1500 2000 Average Abnormal Volume -20-10 -30 0 Event Time All Call Put Average Cumulative Abnormal Volume (# Contracts) 0 5000 10000 15000 Average Cumulative Abnormal Volume -20-10 -30 0 Event Time All Call Put Marti G. Subrahmanyam Informed Options Trading prior to M&A Announcements: Insider Trading? 14 / 50

Abnormal Trading Volume - Event Study Event Study over the 30 days preceding M&A announcements. 26% of deals have abnormal volume in calls. 15% of deals have abnormal volume in puts. Abnormal volume higher for OTM calls. Abnormal volume for ITM Puts? - Weaker evidence. Abnormal volume greater for CASH than for STOCK deals. Figure Cash vs. Stock Marti G. Subrahmanyam Informed Options Trading prior to M&A Announcements: Insider Trading? 14 / 50

Abnormal Trading Volume - Robustness Tests 1. Different Models to predict normal returns. Constant Mean Model, Market Model Mean, Market Model Median, Market Model for Volume (MMV), Market Model for Volume with Lags (MMV-L). Test based on raw volumes and natural log transformations. 2. Multivariate Kolmogorov-Smirnov Test. KS-Test Formal statistical Test of a shift in the bivariate Volume-Moneyness Distribution. Shift stronger for short-dated options ( 30 days). Shift stronger for call options. 3. Identifying the most egregious cases: Strongly Unusual Trading (SUT). SUT Analysis Compare abnormal trading in SUT against Random Sample (RS). Zero Bid, Positive Volume, Expiration after Announcement Date, Trades within 30 days before the Announcement, Front Date Option (First Expiration Month). SUT Volume double than that of a matched random sample. Chance that average volume in RS is larger: 3 in a trillion 4. Equity options are illiquid, there is low volume - exploit zero-volume observations. Chance 1 in a million that # with positive volumes greater in pseudo-sample. Zero Volume Runs Marti G. Subrahmanyam Informed Options Trading prior to M&A Announcements: Insider Trading? 15 / 50

Characteristics of abnormal Volume CABVOL = β 0 + β 1 SIZE + β 2 CASH + β 3 TOE + β 4 PRIVATE + β 5 COLLAR + β 6 TERM + β 7 FRIENDLY + β 8 US + γ t + ε, Call Cumulative Abnormal Volume higher for: (Large) deals, with higher Sales Cash deals Collar deals & Termination Fee (More price certainty?) Put options: Weaker evidence. Marti G. Subrahmanyam Informed Options Trading prior to M&A Announcements: Insider Trading? 16 / 50

Excess Implied Volatility - Event Study Event Study over the 30 days preceding M&A announcts. ATM ( = 50 ) 44% (43%) of deals have EIV in calls (puts) at 5% sign. ITM ( = 80 ) 39% (41%) of deals have EIV in calls (puts) at 5% sign. OTM ( = 20 ) 43% (36%) of deals have EIV in calls (puts) at 5% sign. Frequency of Deals with EIV: higher for ATM/OTM calls than for ITM calls. higher for OTM calls than for OTM puts. lower for ITM calls than for ITM puts. higher for OTM calls than for ITM puts. Average Excess Implied Volatility.01.02.03.04.05-30 -20-10 0 Event Time Call Put Marti G. Subrahmanyam Informed Options Trading prior to M&A Announcements: Insider Trading? 17 / 50

Liquidity - Bid-Ask Spreads % B-A for targets widens from 35% to 55% before M&As. Effect stronger for (and restricted to) OTM and DOTM. Effect stronger for short-dated options. Percentage Bid-Ask Spread, Target Percentage Bid-Ask Spread, Target Percentage Bid-Ask Spread.3.4.5.6.7.8-80 -60-40 -20 0 20 40 60 80 Event Time Percentage Bid-Ask Spread 0.5 1 1.5 2-100 -50 0 50 100 Event Time Actual Random DOTM OTM ATM ITM DITM No such effects on randomized pseudo-event dates. Results for IV Smile Marti G. Subrahmanyam Informed Options Trading prior to M&A Announcements: Insider Trading? 18 / 50

Liquidity - Term Structure Short-dated Calls/Puts become more expensive than Long-Dated Calls/Puts. Slope Effect in the IV. IV-delta50/91 - IV-delta50/30 -.05 -.04 -.03 -.02 -.01 IV-Term Structure (91day - 30day options) ]...,-30] [-24,-20] [-14,-10] [-4,-1] [1,5] [11,15] [21,25] [31,...[ Event Time IV-Term Calls (Mean) IV-Term Puts (Mean) IV-Term Calls Random (Mean) IV-Term Puts Random (Mean) No such effects on randomized pseudo-event dates. Marti G. Subrahmanyam Informed Options Trading prior to M&A Announcements: Insider Trading? 19 / 50

Investor Ability to Predict Takeovers? Model (1) (2) (3) Prob (M&A = 1) = 1 1+exp( α X β) Low takeover propensity scores. Weak explanatory power: ps.r2(%). Difficult to predict: Occurrence of Takeover. Timing of Takeover. Ln Assets 0.15*** 0.14*** 0.22*** WAVE 0.22*** 0.22*** 0.21*** BLOCK 0.44*** 0.43*** 0.39*** Leverage -0.10*** -0.03-0.11*** Log Volume 0.07*** 0.07*** 0.08*** Option1-0.78*** -0.77*** -0.70*** DivYield2-0.05*** PPENT ratio -0.11 ROA 0.19*** 0.14*** ROE -0.02-0.03 CumRet -0.00 RE ratio 0.10*** Q 0.00* MarketEquity -0.00*** Ln Employees -0.03** EPS -0.03*** -0.02*** CAPEX ratio 0.19 Constant -6.44*** -6.20*** -5.21*** Observations 121,696 119,664 101,306 LL -19,884-19,643-16,241 ps.r2(%) 4.35 4.46 4.70 M&A(#) 4,978 4,933 4,061 M&A(%) 4.09 4.12 4.01 M&A in sample(%) 72.83 72.46 67.78 Marti G. Subrahmanyam Informed Options Trading prior to M&A Announcements: Insider Trading? 20 / 50

Speculation? Merger waves cluster across industries and in time. This may give rise to speculative trading in similar firms. Compare options volume in treatment and propensity-matched control group. Abnormal options statistically greater in treatment than in control group. Marti G. Subrahmanyam Informed Options Trading prior to M&A Announcements: Insider Trading? 21 / 50

News and Rumors? RavenPack News Analytics: Identify news and rumors from major newspapers, regulatory/publication relation feeds, social media sites. News and rumors exist for only 9% of all deals in the sample. Are rumors driving our results? Average Abnormal Volume (# Contracts) -.5 0.5 1 Average Abnormal Volume -30-20 -10 0 Event Time Average Cumulative Abnormal Volume (# Contracts) 0 2 4 6 8 Average Cumulative Abnormal Volume -30-20 -10 0 Event Time No News News (30d) No News News (30d) No statistical difference in abnormal options volume between the two samples! Marti G. Subrahmanyam Informed Options Trading prior to M&A Announcements: Insider Trading? 22 / 50

Legal Insider Trading? We examine Table 2 of the Thomson Reuters insider filings: derivative transactions. SEC imposes legal requirement on registered corporate insiders (CEO, CFO, major stakeholders...) to report all transactions in their company s stocks and their derivatives. Result: Not a single transaction, purchase or sale, of a derivative security in the 30 days before the announcement. We document unusual options activity trades not initiated by legal insiders. Registered insiders who trade, but fail to report? Highly unlikely as great risk of investigation by the SEC. Could the unusual trades arise from tippees, tipped by the legal insiders? Possibly. Marti G. Subrahmanyam Informed Options Trading prior to M&A Announcements: Insider Trading? 23 / 50

Leakage and Trading in Stocks? Does leakage lead to insider trading in stocks? Abnormal volume robust to contemporaneous and lagged stock returns. Only 7% of all deals in the sample have abnormal stock returns in the 30 days before the announcement. Cumulative abnormal option volumes greater than cumulative abnormal stock volumes. Marked rise in call-to-stock volume ratio, in particular in the right tail of the distribution. Modest rise in call-to-put volume ratio. Marti G. Subrahmanyam Informed Options Trading prior to M&A Announcements: Insider Trading? 24 / 50

Bottom Line? Pervasive abnormal options activity before M&A announcts: 25% of sample. This is indicative of illicit activity... but cannot be explained by: 1. Ability to predict mergers. 2. Speculation. 3. News and Rumors. 4. Derivative trades by registered insiders. 5. Leakage and trading in stocks. Legal Insiders: Illegal Insiders: Perhaps. Legal Outsiders: : Illegal Outsiders : Marti G. Subrahmanyam Informed Options Trading prior to M&A Announcements: Insider Trading? 25 / 50

SEC Civil Litigation Reports Characteristics of SEC Cases (Yearly Averages) Year SEC LRs ABS Sample Illicit Profits Days to Lit. Moneyness S/K Option Mat. Days to Ann. 96-12 6 109 1,567,976 756 0.94 1 16 SEC Characteristics consistent with our findings: Abnormal volume in short-dated OTM call options within 30 days before announcement. Statistics by Year Probability of SEC litigation larger for Completed deals. Larger deals: size, sales, offer price Firms with higher post-announcement abnormal returns. Foreign bidders. Overall, abnormal volume much more pervasive than what is suggested by the number of SEC litigations: 5% of our sample. Marti G. Subrahmanyam Informed Options Trading prior to M&A Announcements: Insider Trading? 26 / 50

SEC Litigation Reports Pr (SEC = 1) = F (β 0 + β 1 SIZE + β 2 CASH + β 3 TOE + β 4 PRIVATE +β 5 COLLAR + β 6 TERM + β 7 FRIENDLY + β 8 US + γ t ), Probability of SEC litigation larger for Completed deals. Larger deals: size, sales, offer price. Firms with higher post-announcement abnormal returns. Foreign bidders. Endogeneity issue Is SEC more likely to investigate large deals? Are large deals more susceptible of insider trading because of options are more liquid? We don t know! Overal, abnormal volume much more pervasive than what is suggested by the number of SEC litigations. Marti G. Subrahmanyam Informed Options Trading prior to M&A Announcements: Insider Trading? 27 / 50

Evidence on the Acquirer Directional Strategies for Targets, but Volatility Strategies for Acquirers. Increase in ATM options Volume, straddle strategies for example. Increase in the number of ATM strike-matched put-call pairs Straddle Pairs - Acquirer # Pairs 1.4 1.6 1.8 2 1000 1100 1200 1300 1400 1500 # Pairs -30-20 -10 0 10 20 Event Time Volume - # Contracts 200 400 600 800 Straddle Volume - Acquirer -30-20 -10 0 10 20 Event Time 100000 200000 300000 400000 500000 Volume - # Contracts Average Total Average Total Marti G. Subrahmanyam Informed Options Trading prior to M&A Announcements: Insider Trading? 28 / 50

How Random is ATM Volume? We test the likelihood of unusual trading using ATM volume (for acquirer). Compare SUT-A sample vs. Random Sample. 1. ATM options 2. Positive Volume 3. Expiration after Announcement Date 4. Trades within 30 days before the Announcement 5. Front Date Option Chance of 6 in a billion that average volume in the pseudo-sample is larger. Panel A: SUT Selection with the historical 792 event dates for the acquirer Acquirer Obs # Deals # Options Mean Vol Med Vol 25th pctile 75th pctile 95th pctile 99th pctile All 5,343 235 1,035 1045.85 202 35 1,020 4,783 10,927 Calls 2,860 228 534 1257.00 244 38 1,276 5,465 12,110 Puts 2,483 223 501 802.65 163 32 774 3,858 7,939 Panel B: 1 random sample of 792 pseudo event dates for the acquirer Acquirer Obs # Deals # Options Mean Vol Med Vol 25th pctile 75th pctile 95th pctile 99th pctile All 2,258 127 479 657.79 145 30 584 2,925 7,749 Calls 1,206 120 244 758.42 198 35 700 3,263 9,215 Puts 1,052 119 235 542.42 110 25 469 2,434 5,903 Panel C: Tests for Statistical Significance between SUT and Random Samples Target KS (two-sided) KS (one-sided) T-test (Mean) T-test (Mean) H0: SUT=RS SUT RS SUT=RS SUT RS Statistic D D t t Value 0.09 0.09-5.72-5.72 p-val 2.69e-11 1.34e-11 1.12e-08 5.61e-09 Marti G. Subrahmanyam Informed Options Trading prior to M&A Announcements: Insider Trading? 29 / 50

How Random is ATM Volume? We test the likelihood of unusual trading using ATM volume (for acquirer). Compare SUT-A sample vs. Random Sample. 1. ATM options 2. Positive Volume 3. Expiration after Announcement Date 4. Trades within 30 days before the Announcement 5. Front Date Option Chance of 6 in a billion that average volume in the pseudo-sample is larger. Panel A: SUT Selection with the historical 792 event dates for the acquirer Acquirer Obs # Deals # Options Mean Vol Med Vol 25th pctile 75th pctile 95th pctile 99th pctile All 5,343 235 1,035 1045.85 202 35 1,020 4,783 10,927 Calls 2,860 228 534 1257.00 244 38 1,276 5,465 12,110 Puts 2,483 223 501 802.65 163 32 774 3,858 7,939 Panel B: 1 random sample of 792 pseudo event dates for the acquirer Acquirer Obs # Deals # Options Mean Vol Med Vol 25th pctile 75th pctile 95th pctile 99th pctile All 2,258 127 479 657.79 145 30 584 2,925 7,749 Calls 1,206 120 244 758.42 198 35 700 3,263 9,215 Puts 1,052 119 235 542.42 110 25 469 2,434 5,903 Panel C: Tests for Statistical Significance between SUT and Random Samples Target KS (two-sided) KS (one-sided) T-test (Mean) T-test (Mean) H0: SUT=RS SUT RS SUT=RS SUT RS Statistic D D t t Value 0.09 0.09-5.72-5.72 p-val 2.69e-11 1.34e-11 1.12e-08 5.61e-09 Marti G. Subrahmanyam Informed Options Trading prior to M&A Announcements: Insider Trading? 29 / 50

How Random is ATM Volume? We test the likelihood of unusual trading using ATM volume (for acquirer). Compare SUT-A sample vs. Random Sample. 1. ATM options 2. Positive Volume 3. Expiration after Announcement Date 4. Trades within 30 days before the Announcement 5. Front Date Option Chance of 6 in a billion that average volume in the pseudo-sample is larger. Panel A: SUT Selection with the historical 792 event dates for the acquirer Acquirer Obs # Deals # Options Mean Vol Med Vol 25th pctile 75th pctile 95th pctile 99th pctile All 5,343 235 1,035 1045.85 202 35 1,020 4,783 10,927 Calls 2,860 228 534 1257.00 244 38 1,276 5,465 12,110 Puts 2,483 223 501 802.65 163 32 774 3,858 7,939 Panel B: 1 random sample of 792 pseudo event dates for the acquirer Acquirer Obs # Deals # Options Mean Vol Med Vol 25th pctile 75th pctile 95th pctile 99th pctile All 2,258 127 479 657.79 145 30 584 2,925 7,749 Calls 1,206 120 244 758.42 198 35 700 3,263 9,215 Puts 1,052 119 235 542.42 110 25 469 2,434 5,903 Panel C: Tests for Statistical Significance between SUT and Random Samples Target KS (two-sided) KS (one-sided) T-test (Mean) T-test (Mean) H0: SUT=RS SUT RS SUT=RS SUT RS Statistic D D t t Value 0.09 0.09-5.72-5.72 p-val 2.69e-11 1.34e-11 1.12e-08 5.61e-09 Marti G. Subrahmanyam Informed Options Trading prior to M&A Announcements: Insider Trading? 29 / 50

How Random is ATM Volume? We test the likelihood of unusual trading using ATM volume (for acquirer). Compare SUT-A sample vs. Random Sample. 1. ATM options 2. Positive Volume 3. Expiration after Announcement Date 4. Trades within 30 days before the Announcement 5. Front Date Option Chance of 6 in a billion that average volume in the pseudo-sample is larger. Panel A: SUT Selection with the historical 792 event dates for the acquirer Acquirer Obs # Deals # Options Mean Vol Med Vol 25th pctile 75th pctile 95th pctile 99th pctile All 5,343 235 1,035 1045.85 202 35 1,020 4,783 10,927 Calls 2,860 228 534 1257.00 244 38 1,276 5,465 12,110 Puts 2,483 223 501 802.65 163 32 774 3,858 7,939 Panel B: 1 random sample of 792 pseudo event dates for the acquirer Acquirer Obs # Deals # Options Mean Vol Med Vol 25th pctile 75th pctile 95th pctile 99th pctile All 2,258 127 479 657.79 145 30 584 2,925 7,749 Calls 1,206 120 244 758.42 198 35 700 3,263 9,215 Puts 1,052 119 235 542.42 110 25 469 2,434 5,903 Panel C: Tests for Statistical Significance between SUT and Random Samples Target KS (two-sided) KS (one-sided) T-test (Mean) T-test (Mean) H0: SUT=RS SUT RS SUT=RS SUT RS Statistic D D t t Value 0.09 0.09-5.72-5.72 p-val 2.69e-11 1.34e-11 1.12e-08 5.61e-09 Marti G. Subrahmanyam Informed Options Trading prior to M&A Announcements: Insider Trading? 29 / 50

How Random is ATM Volume? We test the likelihood of unusual trading using ATM volume (for acquirer). Compare SUT-A sample vs. Random Sample. 1. ATM options 2. Positive Volume 3. Expiration after Announcement Date 4. Trades within 30 days before the Announcement 5. Front Date Option Chance of 6 in a billion that average volume in the pseudo-sample is larger. Panel A: SUT Selection with the historical 792 event dates for the acquirer Acquirer Obs # Deals # Options Mean Vol Med Vol 25th pctile 75th pctile 95th pctile 99th pctile All 5,343 235 1,035 1045.85 202 35 1,020 4,783 10,927 Calls 2,860 228 534 1257.00 244 38 1,276 5,465 12,110 Puts 2,483 223 501 802.65 163 32 774 3,858 7,939 Panel B: 1 random sample of 792 pseudo event dates for the acquirer Acquirer Obs # Deals # Options Mean Vol Med Vol 25th pctile 75th pctile 95th pctile 99th pctile All 2,258 127 479 657.79 145 30 584 2,925 7,749 Calls 1,206 120 244 758.42 198 35 700 3,263 9,215 Puts 1,052 119 235 542.42 110 25 469 2,434 5,903 Panel C: Tests for Statistical Significance between SUT and Random Samples Target KS (two-sided) KS (one-sided) T-test (Mean) T-test (Mean) H0: SUT=RS SUT RS SUT=RS SUT RS Statistic D D t t Value 0.09 0.09-5.72-5.72 p-val 2.69e-11 1.34e-11 1.12e-08 5.61e-09 Marti G. Subrahmanyam Informed Options Trading prior to M&A Announcements: Insider Trading? 29 / 50

How Random is ATM Volume? We test the likelihood of unusual trading using ATM volume (for acquirer). Compare SUT-A sample vs. Random Sample. 1. ATM options 2. Positive Volume 3. Expiration after Announcement Date 4. Trades within 30 days before the Announcement 5. Front Date Option Chance of 6 in a billion that average volume in the pseudo-sample is larger. Panel A: SUT Selection with the historical 792 event dates for the acquirer Acquirer Obs # Deals # Options Mean Vol Med Vol 25th pctile 75th pctile 95th pctile 99th pctile All 5,343 235 1,035 1045.85 202 35 1,020 4,783 10,927 Calls 2,860 228 534 1257.00 244 38 1,276 5,465 12,110 Puts 2,483 223 501 802.65 163 32 774 3,858 7,939 Panel B: 1 random sample of 792 pseudo event dates for the acquirer Acquirer Obs # Deals # Options Mean Vol Med Vol 25th pctile 75th pctile 95th pctile 99th pctile All 2,258 127 479 657.79 145 30 584 2,925 7,749 Calls 1,206 120 244 758.42 198 35 700 3,263 9,215 Puts 1,052 119 235 542.42 110 25 469 2,434 5,903 Panel C: Tests for Statistical Significance between SUT and Random Samples Target KS (two-sided) KS (one-sided) T-test (Mean) T-test (Mean) H0: SUT=RS SUT RS SUT=RS SUT RS Statistic D D t t Value 0.09 0.09-5.72-5.72 p-val 2.69e-11 1.34e-11 1.12e-08 5.61e-09 Marti G. Subrahmanyam Informed Options Trading prior to M&A Announcements: Insider Trading? 29 / 50

How Random is ATM Volume? We test the likelihood of unusual trading using ATM volume (for acquirer). Compare SUT-A sample vs. Random Sample. 1. ATM options 2. Positive Volume 3. Expiration after Announcement Date 4. Trades within 30 days before the Announcement 5. Front Date Option Chance of 6 in a billion that average volume in the pseudo-sample is larger. Panel A: SUT Selection with the historical 792 event dates for the acquirer Acquirer Obs # Deals # Options Mean Vol Med Vol 25th pctile 75th pctile 95th pctile 99th pctile All 5,343 235 1,035 1045.85 202 35 1,020 4,783 10,927 Calls 2,860 228 534 1257.00 244 38 1,276 5,465 12,110 Puts 2,483 223 501 802.65 163 32 774 3,858 7,939 Panel B: 1 random sample of 792 pseudo event dates for the acquirer Acquirer Obs # Deals # Options Mean Vol Med Vol 25th pctile 75th pctile 95th pctile 99th pctile All 2,258 127 479 657.79 145 30 584 2,925 7,749 Calls 1,206 120 244 758.42 198 35 700 3,263 9,215 Puts 1,052 119 235 542.42 110 25 469 2,434 5,903 Panel C: Tests for Statistical Significance between SUT and Random Samples Target KS (two-sided) KS (one-sided) T-test (Mean) T-test (Mean) H0: SUT=RS SUT RS SUT=RS SUT RS Statistic D D t t Value 0.09 0.09-5.72-5.72 p-val 2.69e-11 1.34e-11 1.12e-08 5.61e-09 Marti G. Subrahmanyam Informed Options Trading prior to M&A Announcements: Insider Trading? 29 / 50

Summary of Results 1. Directional, abnormal and non-random volume in equity options for targets ahead of M&As. Effects stronger for short-dated OTM call options. We quantify the randomness of these statistical anomalies. 2. Excess Implied Volatility. 3. Liquidity Effects: Price Pressure on Calls Widening of B-A Spreads (OTM). Decrease in IV-Term Structure. 4. Evidence consistent with characteristics prosecuted by the SEC, but unusual trading volume more pervasive compared to number of litigation reports by SEC. 5. Preliminary evidence on acquirer: based on volatility trading. Marti G. Subrahmanyam Informed Options Trading prior to M&A Announcements: Insider Trading? 30 / 50

Take-aways! Conclusion Our findings provide evidence of pervasive statistical anomalies consistent with investors trading on private information ahead of M&As. Evidence too strong to be dismissed as speculative noise. 1. Regulators Benefits from dedicating more scrutiny to the options market for detecting rogue trading. Development of forensic analytics for detection of suspicious trading. 2. Corporate America 3. Investors Corporate governance problem of leaking information. Needs to be addressed. Obtain trading ids for large suspicious trades prior to corporate announcements. Are financial markets fair - Level Playing Field? Traders/Investors: Watch out for unusual options activity! Marti G. Subrahmanyam Informed Options Trading prior to M&A Announcements: Insider Trading? 31 / 50

A Smoking Gun? Thank you Marti G. Subrahmanyam Informed Options Trading prior to M&A Announcements: Insider Trading? 32 / 50

More Suspicious Options Trades Unusual options trades before M&As 1 29May2013: Smithfield Foods by Shuanghui 1,300 Jul $29 OTM calls (21 May) + 1,700 Jul $30 OTM calls (28 May). Offer Price: $34; Price 28 May: $25.97; Total Profit: $3.2 million. 21Dec2010: Martek by DSM 2,615 $27 OTM calls (10 Dec). Offer Price: $31.5; Price 20 Dec: $23.36; Total Profit: $1.2 million. 27Sep2010: AirTran by Southwest Airlines 200 Jan calls (22 Sep). Offer Price: $7.69; Price 22 Sep: $4.39; Total Profit: $0.159 million. 2Sep2010: Burger King by 3G Capital 300 July $20 ATM calls (17 May) + 2,850 Jul $22.5 OTM calls (18-19 May) + 2,000 Jul $20 ATM calls (2-17 Jun) + 1,400 Oct $17.5 OTM calls + 206 Oct $19 OTM calls (19 Aug) + 100 Jan $20 OTM calls (25 Aug) + 1,794 Oct $19 OTM calls (26-27 Aug). Offer Price: $24; Price 1 Sep: $18.86; Total Profit: $1.68 million. 15Jan2004: Potash by BHP Billiton 31 Aug $110 ITM calls + 50 Aug $115 OTM calls + 95 Aug $120 OTM calls + 22 Aug $125 OTM calls + 32 Aug $130 OTM calls (12 Aug) + 5 Aug $115 OTM calls + 12 Aug $120 OTM calls (13 Aug) + 50 Aug $130 OTM calls + 5 Sep $110 ATM calls + 5 Sep $115 OTM calls + 5 Sep $120 OTM calls (16 Aug) + 331 Sep $125 OTM calls (12-13 Aug). Offer Price: $130; Price 16 Aug: $110.57; Total Profit: $1.073 million. Back to Motivation 1 Source: http://www.sec.gov/spotlight/insidertrading/cases.shtml Marti G. Subrahmanyam Informed Options Trading prior to M&A Announcements: Insider Trading? 33 / 50

Why do we care? SEC Enforcement Actions: Insider Trading Cases Insider trading continues to be a high priority area for the SEC s enforcement program. The SEC brought 58 insider trading actions in FY 2012 against 131 individuals and entities. Over the last three years, the SEC has filed more insider trading actions (168 total) than in any three-year period in the agency s history. These insider trading actions were filed against nearly 400 individuals and entities with illicit profits or losses avoided totaling approximately $600 million. Many of these actions involved financial professionals, hedge fund managers, corporate insiders, and attorneys who unlawfully traded on material nonpublic information, undermining the level playing field that is fundamental to the integrity and fair functioning of the capital markets. 2 Back to Motivation 2 https://www.sec.gov/spotlight/insidertrading/cases.shtml Marti G. Subrahmanyam Informed Options Trading prior to M&A Announcements: Insider Trading? 34 / 50

SEC Definition of Insider Trading Illegal insider trading refers generally to buying or selling a security, in breach of a fiduciary duty or other relationship of trust and confidence, while in possession of material, nonpublic information about the security. Insider trading violations may also include tipping such information, securities trading by the person tipped, and securities trading by those who misappropriate such information. 3 Breach of fiduciary duty is key. There is a fine line between legal or illegal insider trading - we talk about statistical anomalies. Insider Trading can come from registered corporate insiders or outsiders. We make no distinction in our statistical analysis: some of our cases could be by insiders who filed SEC Forms 3 and 4, although unlikely. Back to Motivation 3 http://www.sec.gov/spotlight/insidertrading.shtml Marti G. Subrahmanyam Informed Options Trading prior to M&A Announcements: Insider Trading? 35 / 50

Options Strategies An informed trader expects an increase in the target s stock price and benefits from: 1. Long Bullish Strategies (+ replications) 2. Short Bearish Strategies (+ replications) Strategies 1. Long OTM Call K 1 (Replication: Long ITM Put K 1 + Long Stock) 2. Long Call Ratio Backspread (Short OTM Call K 1, Long 2 OTM Calls K 2 > K 1 ) Replication example: Short ITM Put K 1, Short Stock, Buy 2 OTM Calls K 2 > K 1 3. Long Bull Call Spread (Long OTM Call K 1, Short OTM Call K 2 > K 1 ) Replication example: Long OTM Call K 1, Short ITM Put K 2 > K 1, Short Stock 4. Long Bull Put Spread (Long ITM Put K 1, Short ITM Put K 2 > K 1 ) Replication example: Long ITM Put K 1, Short OTM Call K 2 > K 1, Long Stock 5. Short ITM Put K 1 (Short OTM Call K 1 + Long Stock = Covered Call) 6. Short Put Ratio Backspread (Short 2 ITM Puts K 1, Long ITM Put K 2 > K 1 ) Replication example: Short 2 ITM Puts K 1, Long OTM Call K 2 > K 1, Long Stock 7. Short Bear Call Spread (Long OTM Call K 1, Short OTM Call K 2 > K 1 ) 8. Short Bear Put Spread (Long ITM Put K 1, Short ITM Put K 2 > K 1 ) Conclusion: Any strategy leads to abnormal volume in OTM calls/itm puts. 1. Could be buys or sells. Back to Hypotheses 2. OptionMetrics reports non-signed aggregate volume, so ok. 3. Increase in Call/Stock and Call/Put Volume, but flat Put/Stock Volume. Marti G. Subrahmanyam Informed Options Trading prior to M&A Announcements: Insider Trading? 36 / 50

Literature Insider Trading (IT) (other than by corporate insiders/edgar filings) Keown and Pinkerton (JF1981): focus on excess stock returns around M&As. Meulbroek (JF1992): investigates SEC prosecuted cases, focus on stocks. Poteshman (JB2006): unusal put volume trading before 9/11 attack. Acharya and Johnson (JFE2010): More insiders (syndicate) in LBOs, more IT. Chesney et al. (WP2011): Develop statistical tools for the detection of IT. Frino et al. (IRF2013): Determinants of illegal IT in stocks based on SEC litigations. Wang (JEB2013): Abnormal volume predicts SEC litigations. Informed Trading in options around M&A Cao et al. (JB 2005): Targets - call volume imbalance predicts future stock returns prior to announcements. Chan et al. (JFQA 2013): Acquirers - IV spread (IV skew) positively (negatively) predicts CARs. Barraclough et al. (RFS 2012): Use options to measure synergies in M&As. Spyrou et al. (JFM 2011): UK evidence for abnormal volume before M&As. Podolski et al. (JIFMIM 2013): Regulation affects quantity of informed trading. Other literature Back to Presentation Where do insiders trade? Easley et al. (JF1998), John et al. (WP2003), Cao and Ou-Yang (RFS2009),... Informational Content of Option Volume/Price for Stock Returns. Hu (JFE 2013), Jin et al. (JAR 2012), Driessen et al. (WP 2012), Johnson and So (JFE 2011), Pan and Poteshman (RFS 2006)... Price Pressure in options Bollen and Whaley (JF2004) and Garleanu et al. (RFS2009) Option Pricing Models around informational events Bester et al. (WP2011), Subramanian (JF2004), Johannes (WP2006) Marti G. Subrahmanyam Informed Options Trading prior to M&A Announcements: Insider Trading? 37 / 50

Deal Size Distribution Largest Cash deal: InBev - Anheuser Busch (Jun 11, 2008) Largest Hybrid deal: Pfizer - Wyeth (Jan 26, 2009) Largest Other deal: Comcast - MediaOne (withdrawn, Mar 22, 1999) Largest Stock deal: AOL - Time Warner (Jan 10, 2000) Largest Unknown deal: Hilton Hotel - ITT (withdrawn, Jan 27, 1997) Deal Transaction Value Offer Structure Mean Min P1 P5 P25 P50 P75 P95 P99 Max N Cash Only (48%) $2,242.0 $3.0 $58.8 $143.4 $417.0 $1,012.2 $2,247.4 $7,811.2 $25,065.2 $52,177.7 903 Hybrid (22%) $5,880.9 $34.5 $76.3 $234.1 $885.7 $2,433.9 $5,981.8 $25,818.3 $56,307.0 $67,285.7 415 Other (4%) $5,074.2 $24.4 $24.4 $158.7 $476.7 $1,326.5 $4,502.7 $26,459.1 $58,511.8 $58,511.8 80 Shares (21%) $5,429.8 $30.4 $57.7 $128.4 $424.5 $1,128.4 $3,169.5 $24,517.7 $75,563.2 $164,746.9 403 Unknown (3%) $1,635.7 $16.8 $16.8 $49.7 $250.0 $489.1 $2,318.7 $7,486.2 $13,608.4 $13,608.4 58 Total (100%) $3,848.4 $3.0 $48.2 $141.3 $468.7 $1,245.4 $3,270.3 $14,391.7 $53,414.6 $164,746.9 1,859 N pctile 1,460 1 18 92 464 930 1,396 1,766 1,841 1,859 - Back to Sample Characteristics Marti G. Subrahmanyam Informed Options Trading prior to M&A Announcements: Insider Trading? 38 / 50

Options Trading Acquirer - Summary Statistics Trading Volume higher in Short-term and medium-dated options. Higher Trading Volume in ATM options. Acquirer (N = 3,582,394) DITM Mean SD Min Med p75 p90 Max Panel A: All options, TTE = [0,30] DOTM (10%) 127 594 1 20 71 231 27,377 OTM (22%) 497 1,497 1 79 355 1,207 55,167 ATM (26%) 1,084 3,038 1 204 927 2,744 198,146 ITM (23%) 398 5,209 1 42 175 624 679,620 DITM (16%) 214 3,286 1 16 54 191 300,841 Total (100%) 547 3,361 1 52 279 1,146 679,620 Panel B: All options, TTE = ]30,60] DOTM (14%) 141 838 1 20 76 245 95,000 OTM (27%) 384 1,388 1 69 269 830 94,552 ATM (25%) 551 1,666 1 101 425 1,299 90,497 ITM (20%) 236 3,488 1 30 108 367 458,019 DITM (12%) 334 12,543 1 11 40 133 1,609,002 Total (100%) 354 4,841 1 41 183 659 1,609,002 Back to Target Statistics Marti G. Subrahmanyam Informed Options Trading prior to M&A Announcements: Insider Trading? 39 / 50

Abnormal Trading Volume - Event Study Average Abnormal Volume (# Contracts) -1000 0 1000 2000 Average Abnormal Volume -30-20 -10 0 Event Time Average Cumulative Abnormal Volume (# Contracts) 0 5000 10000 15000 20000 Average Cumulative Abnormal Volume -30-20 -10 0 Event Time Cash Stock Cash Stock Back to Abnormal Trading Volume Marti G. Subrahmanyam Informed Options Trading prior to M&A Announcements: Insider Trading? 40 / 50

Shifts in Option Trading Volume Density Formal statistical Test of a shift in the bivariate Volume-Moneyness Distribution: Multivariate Kolmogorov-Smirnov. Statistic measures the distance between empirical cumulative distribution functions in 2 event windows [t 1, t 2 ]. Shift stronger for short-dated options ( 30 days). Shift stronger for call options. Marti G. Subrahmanyam Informed Options Trading prior to M&A Announcements: Insider Trading? 41 / 50

Shifts in Option Trading Volume Density...continued Call Options - Target Volume (# Contracts) - Polynomial Fit 0 50 100 150 0.5 1 1.5 2 S/K Full Sample ex-ew [-29,-25] [-24,-20] [-19,-15] [-14,-10] [-9,-5] [-4,-1] [0,0] Back to Empirical Analysis Marti G. Subrahmanyam Informed Options Trading prior to M&A Announcements: Insider Trading? 42 / 50

Shifts in Option Trading Volume Density...continued Call Options - Target Volume (# Contracts) - Polynomial Fit 0 50 100 150 0.5 1 1.5 2 S/K Full Sample ex-ew [-29,-25] [-24,-20] [-19,-15] [-14,-10] [-9,-5] [-4,-1] [0,0] Back to Empirical Analysis Marti G. Subrahmanyam Informed Options Trading prior to M&A Announcements: Insider Trading? 42 / 50

Shifts in Option Trading Volume Density...continued Call Options - Target Volume (# Contracts) - Polynomial Fit 0 50 100 150 0.5 1 1.5 2 S/K Full Sample ex-ew [-29,-25] [-24,-20] [-19,-15] [-14,-10] [-9,-5] [-4,-1] [0,0] Back to Empirical Analysis Marti G. Subrahmanyam Informed Options Trading prior to M&A Announcements: Insider Trading? 42 / 50

Shifts in Option Trading Volume Density...continued Call Options - Target Volume (# Contracts) - Polynomial Fit 0 50 100 150 0.5 1 1.5 2 S/K Full Sample ex-ew [-29,-25] [-24,-20] [-19,-15] [-14,-10] [-9,-5] [-4,-1] [0,0] Back to Empirical Analysis Marti G. Subrahmanyam Informed Options Trading prior to M&A Announcements: Insider Trading? 42 / 50

Shifts in Option Trading Volume Density...continued Call Options - Target Volume (# Contracts) - Polynomial Fit 0 50 100 150 0.5 1 1.5 2 S/K Full Sample ex-ew [-29,-25] [-24,-20] [-19,-15] [-14,-10] [-9,-5] [-4,-1] [0,0] Back to Empirical Analysis Marti G. Subrahmanyam Informed Options Trading prior to M&A Announcements: Insider Trading? 42 / 50

Shifts in Option Trading Volume Density...continued Call Options - Target Volume (# Contracts) - Polynomial Fit 0 50 100 150 0.5 1 1.5 2 S/K Full Sample ex-ew [-29,-25] [-24,-20] [-19,-15] [-14,-10] [-9,-5] [-4,-1] [0,0] Back to Empirical Analysis Marti G. Subrahmanyam Informed Options Trading prior to M&A Announcements: Insider Trading? 42 / 50

Shifts in Option Trading Volume Density...continued Call Options - Target Volume (# Contracts) - Polynomial Fit 0 50 100 150 0.5 1 1.5 2 S/K Full Sample ex-ew [-29,-25] [-24,-20] [-19,-15] [-14,-10] [-9,-5] [-4,-1] [0,0] Back to Empirical Analysis Marti G. Subrahmanyam Informed Options Trading prior to M&A Announcements: Insider Trading? 42 / 50

Shifts in Option Trading Volume Density...continued Call Options - Target Volume (# Contracts) - Polynomial Fit 0 50 100 150 0.5 1 1.5 2 S/K Full Sample ex-ew [-29,-25] [-24,-20] [-19,-15] [-14,-10] [-9,-5] [-4,-1] [0,0] Back to Empirical Analysis Marti G. Subrahmanyam Informed Options Trading prior to M&A Announcements: Insider Trading? 42 / 50

Shifts in Option Trading Volume Density Volume (# Contracts) - Polynomial Fit 0 20 40 60 80 100 Put Options - Target 0.5 1 1.5 2 S/K Full Sample ex-ew [-29,-25] [-24,-20] [-19,-15] [-14,-10] [-9,-5] [-4,-1] [0,0] Back to Empirical Analysis Marti G. Subrahmanyam Informed Options Trading prior to M&A Announcements: Insider Trading? 43 / 50

Shifts in Option Trading Volume Density Volume (# Contracts) - Polynomial Fit 0 20 40 60 80 100 Put Options - Target 0.5 1 1.5 2 S/K Full Sample ex-ew [-29,-25] [-24,-20] [-19,-15] [-14,-10] [-9,-5] [-4,-1] [0,0] Back to Empirical Analysis Marti G. Subrahmanyam Informed Options Trading prior to M&A Announcements: Insider Trading? 43 / 50

Shifts in Option Trading Volume Density Volume (# Contracts) - Polynomial Fit 0 20 40 60 80 100 Put Options - Target 0.5 1 1.5 2 S/K Full Sample ex-ew [-29,-25] [-24,-20] [-19,-15] [-14,-10] [-9,-5] [-4,-1] [0,0] Back to Empirical Analysis Marti G. Subrahmanyam Informed Options Trading prior to M&A Announcements: Insider Trading? 43 / 50

Shifts in Option Trading Volume Density Volume (# Contracts) - Polynomial Fit 0 20 40 60 80 100 Put Options - Target 0.5 1 1.5 2 S/K Full Sample ex-ew [-29,-25] [-24,-20] [-19,-15] [-14,-10] [-9,-5] [-4,-1] [0,0] Back to Empirical Analysis Marti G. Subrahmanyam Informed Options Trading prior to M&A Announcements: Insider Trading? 43 / 50

Shifts in Option Trading Volume Density Volume (# Contracts) - Polynomial Fit 0 20 40 60 80 100 Put Options - Target 0.5 1 1.5 2 S/K Full Sample ex-ew [-29,-25] [-24,-20] [-19,-15] [-14,-10] [-9,-5] [-4,-1] [0,0] Back to Empirical Analysis Marti G. Subrahmanyam Informed Options Trading prior to M&A Announcements: Insider Trading? 43 / 50

Shifts in Option Trading Volume Density Volume (# Contracts) - Polynomial Fit 0 20 40 60 80 100 Put Options - Target 0.5 1 1.5 2 S/K Full Sample ex-ew [-29,-25] [-24,-20] [-19,-15] [-14,-10] [-9,-5] [-4,-1] [0,0] Back to Empirical Analysis Marti G. Subrahmanyam Informed Options Trading prior to M&A Announcements: Insider Trading? 43 / 50

Shifts in Option Trading Volume Density Volume (# Contracts) - Polynomial Fit 0 20 40 60 80 100 Put Options - Target 0.5 1 1.5 2 S/K Full Sample ex-ew [-29,-25] [-24,-20] [-19,-15] [-14,-10] [-9,-5] [-4,-1] [0,0] Back to Empirical Analysis Marti G. Subrahmanyam Informed Options Trading prior to M&A Announcements: Insider Trading? 43 / 50

Shifts in Option Trading Volume Density Volume (# Contracts) - Polynomial Fit 0 20 40 60 80 100 Put Options - Target 0.5 1 1.5 2 S/K Full Sample ex-ew [-29,-25] [-24,-20] [-19,-15] [-14,-10] [-9,-5] [-4,-1] [0,0] Back to Empirical Analysis Marti G. Subrahmanyam Informed Options Trading prior to M&A Announcements: Insider Trading? 43 / 50

Shift in Volume Distribution Rise in interquartile range and upper percentiles of the distribution. Volume (# Contracts) 0 500 1000 1500 2000 Call Options Volume Distribution - Target -30-20 -10 0 10 20 Event Time 50 100 150 200 Interquartile Range Volume (# Contracts) 0 500 1000 1500 2000 Put Options Volume Distribution - Target -30-20 -10 0 10 20 Event Time 40 60 80 100 120 140 Interquartile Range 90th percentile 95th percentile Interquartile Range 90th percentile 95th percentile Interquartile Range Back to Empirical Analysis Marti G. Subrahmanyam Informed Options Trading prior to M&A Announcements: Insider Trading? 44 / 50

Bivariate Kolmogorov-Smirnov Test Non-parametric test for equality of 2 continuous distribution functions. KS statistic quantifies the distance between 2 empirical cumulative distribution functions (ECDFs). Fasano and Franceschini (FF) generalization of the two-sample bivariate KS test. ( ) ( ) Two samples { xj 1, y j 1 : 1 j n} and { xj 2, y j 2 : 1 j m}, with ECDFs H (k) n and H (k) m for k = 1, 2, 3, 4. H (1) (x, y) = P [X x; Y y] H (2) (x, y) = P [X x; Y y] H (3) (x, y) = P [X x; Y y] H (4) (x, y) = P [X x; Y y] FF-statistic defined as Z n,m = max{t (1) n,m, T (2) n,m, T (3) n,m, T (4) n,m}, where T n,m (k) = sup (x,y) R 2 nm n + m H (k) n (x, y) H m (k) (x, y) Marti G. Subrahmanyam Informed Options Trading prior to M&A Announcements: Insider Trading? 45 / 50

Shifts in Option Trading Volume Density...continued Panel A: Calls Full Sample Event Window [ 29, 25] [ 24, 20] [ 19, 15] [ 14, 10] [ 9, 5] [ 4, 1] [0, 0] [ 29, 25]. 0.0279 0.0482 0.0616 0.1007 0.1592 0.4070 [ 24, 20].. 0.0228 0.0368 0.0744 0.1334 0.3911 [ 19, 15]... 0.0173 0.0556 0.1134 0.3694 [ 14, 10].... 0.0410 0.0988 0.3581 [ 9, 5]..... 0.0606 0.3256 [ 4, 1]...... 0.2798 [0, 0]....... Shift stronger for short-dated options ( 30 days). Shift stronger for call options. Back to Empirical Analysis Marti G. Subrahmanyam Informed Options Trading prior to M&A Announcements: Insider Trading? 46 / 50

Is Unusual Options Trading Volume Random? We test the likelihood of unusual trading using the most obvious cases. Compare SUT sample vs. Random Sample. Back to Empirical Analysis 1. Zero Bid 2. Positive Volume 3. Expiration after Announcement Date 4. Trades within 30 days before the Announcement 5. Front Date Option Chance of 3 in a trillion that average volume in the pseudo-sample is larger. Panel A: SUT Selection with the historical 1,859 event dates for the target - Zero Bid Target Obs # Deals # Options Mean Vol Med Vol 25th pctile 75th pctile 95th pctile 99th pctile All 2,042 437 1,243 123.78 20 6 62 479 2,076 Calls 1,106 299 570 137.23 20 5 65 543 2,517 Puts 936 316 673 107.9 20 7.5 60 390 1,494 Panel B: 1 random sample of 1,859 pseudo event dates for the target Target Obs # Deals # Options Mean Vol Med Vol 25th pctile 75th pctile 95th pctile 99th pctile All 3,412 574 1,901 57 10 5 32 200 813 Calls 1,813 351 941 64 11 5 40 232 893 Puts 1,599 387 960 49 10 5 30 182 759 Panel C: Tests for Statistical Significance between SUT and Random Samples with All Options Target KS (two-sided) KS (one-sided) T-test (Mean) T-test (Mean) H0: SUT=RS SUT RS SUT=RS SUT RS Statistic D D t t Value 0.12 0.12-6.90-6.90 p-val 2.80e-12 4.14e-17 5.99e-12 2.99e-12 Marti G. Subrahmanyam Informed Options Trading prior to M&A Announcements: Insider Trading? 47 / 50

Is Unusual Options Trading Volume Random? We test the likelihood of unusual trading using the most obvious cases. Compare SUT sample vs. Random Sample. Back to Empirical Analysis 1. Zero Bid 2. Positive Volume 3. Expiration after Announcement Date 4. Trades within 30 days before the Announcement 5. Front Date Option Chance of 3 in a trillion that average volume in the pseudo-sample is larger. Panel A: SUT Selection with the historical 1,859 event dates for the target - Zero Bid Target Obs # Deals # Options Mean Vol Med Vol 25th pctile 75th pctile 95th pctile 99th pctile All 2,042 437 1,243 123.78 20 6 62 479 2,076 Calls 1,106 299 570 137.23 20 5 65 543 2,517 Puts 936 316 673 107.9 20 7.5 60 390 1,494 Panel B: 1 random sample of 1,859 pseudo event dates for the target Target Obs # Deals # Options Mean Vol Med Vol 25th pctile 75th pctile 95th pctile 99th pctile All 3,412 574 1,901 57 10 5 32 200 813 Calls 1,813 351 941 64 11 5 40 232 893 Puts 1,599 387 960 49 10 5 30 182 759 Panel C: Tests for Statistical Significance between SUT and Random Samples with All Options Target KS (two-sided) KS (one-sided) T-test (Mean) T-test (Mean) H0: SUT=RS SUT RS SUT=RS SUT RS Statistic D D t t Value 0.12 0.12-6.90-6.90 p-val 2.80e-12 4.14e-17 5.99e-12 2.99e-12 Marti G. Subrahmanyam Informed Options Trading prior to M&A Announcements: Insider Trading? 47 / 50

Is Unusual Options Trading Volume Random? We test the likelihood of unusual trading using the most obvious cases. Compare SUT sample vs. Random Sample. Back to Empirical Analysis 1. Zero Bid 2. Positive Volume 3. Expiration after Announcement Date 4. Trades within 30 days before the Announcement 5. Front Date Option Chance of 3 in a trillion that average volume in the pseudo-sample is larger. Panel A: SUT Selection with the historical 1,859 event dates for the target - Zero Bid Target Obs # Deals # Options Mean Vol Med Vol 25th pctile 75th pctile 95th pctile 99th pctile All 2,042 437 1,243 123.78 20 6 62 479 2,076 Calls 1,106 299 570 137.23 20 5 65 543 2,517 Puts 936 316 673 107.9 20 7.5 60 390 1,494 Panel B: 1 random sample of 1,859 pseudo event dates for the target Target Obs # Deals # Options Mean Vol Med Vol 25th pctile 75th pctile 95th pctile 99th pctile All 3,412 574 1,901 57 10 5 32 200 813 Calls 1,813 351 941 64 11 5 40 232 893 Puts 1,599 387 960 49 10 5 30 182 759 Panel C: Tests for Statistical Significance between SUT and Random Samples with All Options Target KS (two-sided) KS (one-sided) T-test (Mean) T-test (Mean) H0: SUT=RS SUT RS SUT=RS SUT RS Statistic D D t t Value 0.12 0.12-6.90-6.90 p-val 2.80e-12 4.14e-17 5.99e-12 2.99e-12 Marti G. Subrahmanyam Informed Options Trading prior to M&A Announcements: Insider Trading? 47 / 50

Is Unusual Options Trading Volume Random? We test the likelihood of unusual trading using the most obvious cases. Compare SUT sample vs. Random Sample. Back to Empirical Analysis 1. Zero Bid 2. Positive Volume 3. Expiration after Announcement Date 4. Trades within 30 days before the Announcement 5. Front Date Option Chance of 3 in a trillion that average volume in the pseudo-sample is larger. Panel A: SUT Selection with the historical 1,859 event dates for the target - Zero Bid Target Obs # Deals # Options Mean Vol Med Vol 25th pctile 75th pctile 95th pctile 99th pctile All 2,042 437 1,243 123.78 20 6 62 479 2,076 Calls 1,106 299 570 137.23 20 5 65 543 2,517 Puts 936 316 673 107.9 20 7.5 60 390 1,494 Panel B: 1 random sample of 1,859 pseudo event dates for the target Target Obs # Deals # Options Mean Vol Med Vol 25th pctile 75th pctile 95th pctile 99th pctile All 3,412 574 1,901 57 10 5 32 200 813 Calls 1,813 351 941 64 11 5 40 232 893 Puts 1,599 387 960 49 10 5 30 182 759 Panel C: Tests for Statistical Significance between SUT and Random Samples with All Options Target KS (two-sided) KS (one-sided) T-test (Mean) T-test (Mean) H0: SUT=RS SUT RS SUT=RS SUT RS Statistic D D t t Value 0.12 0.12-6.90-6.90 p-val 2.80e-12 4.14e-17 5.99e-12 2.99e-12 Marti G. Subrahmanyam Informed Options Trading prior to M&A Announcements: Insider Trading? 47 / 50

Is Unusual Options Trading Volume Random? We test the likelihood of unusual trading using the most obvious cases. Compare SUT sample vs. Random Sample. Back to Empirical Analysis 1. Zero Bid 2. Positive Volume 3. Expiration after Announcement Date 4. Trades within 30 days before the Announcement 5. Front Date Option Chance of 3 in a trillion that average volume in the pseudo-sample is larger. Panel A: SUT Selection with the historical 1,859 event dates for the target - Zero Bid Target Obs # Deals # Options Mean Vol Med Vol 25th pctile 75th pctile 95th pctile 99th pctile All 2,042 437 1,243 123.78 20 6 62 479 2,076 Calls 1,106 299 570 137.23 20 5 65 543 2,517 Puts 936 316 673 107.9 20 7.5 60 390 1,494 Panel B: 1 random sample of 1,859 pseudo event dates for the target Target Obs # Deals # Options Mean Vol Med Vol 25th pctile 75th pctile 95th pctile 99th pctile All 3,412 574 1,901 57 10 5 32 200 813 Calls 1,813 351 941 64 11 5 40 232 893 Puts 1,599 387 960 49 10 5 30 182 759 Panel C: Tests for Statistical Significance between SUT and Random Samples with All Options Target KS (two-sided) KS (one-sided) T-test (Mean) T-test (Mean) H0: SUT=RS SUT RS SUT=RS SUT RS Statistic D D t t Value 0.12 0.12-6.90-6.90 p-val 2.80e-12 4.14e-17 5.99e-12 2.99e-12 Marti G. Subrahmanyam Informed Options Trading prior to M&A Announcements: Insider Trading? 47 / 50

Is Unusual Options Trading Volume Random? We test the likelihood of unusual trading using the most obvious cases. Compare SUT sample vs. Random Sample. Back to Empirical Analysis 1. Zero Bid 2. Positive Volume 3. Expiration after Announcement Date 4. Trades within 30 days before the Announcement 5. Front Date Option Chance of 3 in a trillion that average volume in the pseudo-sample is larger. Panel A: SUT Selection with the historical 1,859 event dates for the target - Zero Bid Target Obs # Deals # Options Mean Vol Med Vol 25th pctile 75th pctile 95th pctile 99th pctile All 2,042 437 1,243 123.78 20 6 62 479 2,076 Calls 1,106 299 570 137.23 20 5 65 543 2,517 Puts 936 316 673 107.9 20 7.5 60 390 1,494 Panel B: 1 random sample of 1,859 pseudo event dates for the target Target Obs # Deals # Options Mean Vol Med Vol 25th pctile 75th pctile 95th pctile 99th pctile All 3,412 574 1,901 57 10 5 32 200 813 Calls 1,813 351 941 64 11 5 40 232 893 Puts 1,599 387 960 49 10 5 30 182 759 Panel C: Tests for Statistical Significance between SUT and Random Samples with All Options Target KS (two-sided) KS (one-sided) T-test (Mean) T-test (Mean) H0: SUT=RS SUT RS SUT=RS SUT RS Statistic D D t t Value 0.12 0.12-6.90-6.90 p-val 2.80e-12 4.14e-17 5.99e-12 2.99e-12 Marti G. Subrahmanyam Informed Options Trading prior to M&A Announcements: Insider Trading? 47 / 50

Is Unusual Options Trading Volume Random? We test the likelihood of unusual trading using the most obvious cases. Compare SUT sample vs. Random Sample. Back to Empirical Analysis 1. Zero Bid 2. Positive Volume 3. Expiration after Announcement Date 4. Trades within 30 days before the Announcement 5. Front Date Option Chance of 3 in a trillion that average volume in the pseudo-sample is larger. Panel A: SUT Selection with the historical 1,859 event dates for the target - Zero Bid Target Obs # Deals # Options Mean Vol Med Vol 25th pctile 75th pctile 95th pctile 99th pctile All 2,042 437 1,243 123.78 20 6 62 479 2,076 Calls 1,106 299 570 137.23 20 5 65 543 2,517 Puts 936 316 673 107.9 20 7.5 60 390 1,494 Panel B: 1 random sample of 1,859 pseudo event dates for the target Target Obs # Deals # Options Mean Vol Med Vol 25th pctile 75th pctile 95th pctile 99th pctile All 3,412 574 1,901 57 10 5 32 200 813 Calls 1,813 351 941 64 11 5 40 232 893 Puts 1,599 387 960 49 10 5 30 182 759 Panel C: Tests for Statistical Significance between SUT and Random Samples with All Options Target KS (two-sided) KS (one-sided) T-test (Mean) T-test (Mean) H0: SUT=RS SUT RS SUT=RS SUT RS Statistic D D t t Value 0.12 0.12-6.90-6.90 p-val 2.80e-12 4.14e-17 5.99e-12 2.99e-12 Marti G. Subrahmanyam Informed Options Trading prior to M&A Announcements: Insider Trading? 47 / 50

Is Unusual Options Trading Volume Random? - 2 Equity options are illiquid, there is low volume - exploit zero-volume observations Chance 1 in a million that # with positive volumes greater in pseudo-sample. Empirical Analysis DOTM OTM ATM ITM DITM Full Sample Panel B: Full Sample N 3,411,873 1,428,467 2,380,397 1,428,286 3,412,545 12,061,568 P(Vt > 0) 0.1033 0.2581 0.3487 0.1584 0.0688 0.1668 P(Vt 1000) 0.0022 0.0076 0.0144 0.0034 0.0010 0.0050 Panel C: t [ 5, 1] - Actual vs. Random N 78,424 32,500 27,074 32,540 78,436 248,974 N RS 34,508 15,185 21,066 15,192 34,553 120,504 P(Vt > 0) Actual 0.1155 0.3681 0.4265 0.2408 0.0922 0.1913 Random 0.0982 0.2519 0.3239 0.1502 0.0695 0.1554 # SD away 11 33 32 31 17 34 P(Vt 1000) Actual 0.0038 0.0165 0.0260 0.0067 0.0023 0.0078 Random 0.0016 0.0052 0.0110 0.0024 0.0008 0.0036 # SD away 10 19 21 11 10 24 P(Vt > 0 5 i=1 V t i = 0) Actual 0.0676 0.0799 0.0481 0.1004 0.0650 0.0705 Random 0.0568 0.0583 0.0371 0.0623 0.0485 0.0518 # SD away 9 11 8 19 14 29 P(Vt 1000 5 i=1 V t i = 0) Actual 0.0021 0.0036 0.0025 0.0023 0.0017 0.0022 Random 0.0009 0.0014 0.0015 0.0011 0.0007 0.0010 # SD away 7 7 4 5 7 13 Marti G. Subrahmanyam Informed Options Trading prior to M&A Announcements: Insider Trading? 48 / 50

Is Unusual Options Trading Volume Random? - 2 Equity options are illiquid, there is low volume - exploit zero-volume observations Chance 1 in a million that # with positive volumes greater in pseudo-sample. Empirical Analysis DOTM OTM ATM ITM DITM Full Sample Panel B: Full Sample N 3,411,873 1,428,467 2,380,397 1,428,286 3,412,545 12,061,568 P(Vt > 0) 0.1033 0.2581 0.3487 0.1584 0.0688 0.1668 P(Vt 1000) 0.0022 0.0076 0.0144 0.0034 0.0010 0.0050 Panel C: t [ 5, 1] - Actual vs. Random N 78,424 32,500 27,074 32,540 78,436 248,974 N RS 34,508 15,185 21,066 15,192 34,553 120,504 P(Vt > 0) Actual 0.1155 0.3681 0.4265 0.2408 0.0922 0.1913 Random 0.0982 0.2519 0.3239 0.1502 0.0695 0.1554 # SD away 11 33 32 31 17 34 P(Vt 1000) Actual 0.0038 0.0165 0.0260 0.0067 0.0023 0.0078 Random 0.0016 0.0052 0.0110 0.0024 0.0008 0.0036 # SD away 10 19 21 11 10 24 P(Vt > 0 5 i=1 V t i = 0) Actual 0.0676 0.0799 0.0481 0.1004 0.0650 0.0705 Random 0.0568 0.0583 0.0371 0.0623 0.0485 0.0518 # SD away 9 11 8 19 14 29 P(Vt 1000 5 i=1 V t i = 0) Actual 0.0021 0.0036 0.0025 0.0023 0.0017 0.0022 Random 0.0009 0.0014 0.0015 0.0011 0.0007 0.0010 # SD away 7 7 4 5 7 13 Marti G. Subrahmanyam Informed Options Trading prior to M&A Announcements: Insider Trading? 48 / 50

Is Unusual Options Trading Volume Random? - 2 Equity options are illiquid, there is low volume - exploit zero-volume observations Chance 1 in a million that # with positive volumes greater in pseudo-sample. Empirical Analysis DOTM OTM ATM ITM DITM Full Sample Panel B: Full Sample N 3,411,873 1,428,467 2,380,397 1,428,286 3,412,545 12,061,568 P(Vt > 0) 0.1033 0.2581 0.3487 0.1584 0.0688 0.1668 P(Vt 1000) 0.0022 0.0076 0.0144 0.0034 0.0010 0.0050 Panel C: t [ 5, 1] - Actual vs. Random N 78,424 32,500 27,074 32,540 78,436 248,974 N RS 34,508 15,185 21,066 15,192 34,553 120,504 P(Vt > 0) Actual 0.1155 0.3681 0.4265 0.2408 0.0922 0.1913 Random 0.0982 0.2519 0.3239 0.1502 0.0695 0.1554 # SD away 11 33 32 31 17 34 P(Vt 1000) Actual 0.0038 0.0165 0.0260 0.0067 0.0023 0.0078 Random 0.0016 0.0052 0.0110 0.0024 0.0008 0.0036 # SD away 10 19 21 11 10 24 P(Vt > 0 5 i=1 V t i = 0) Actual 0.0676 0.0799 0.0481 0.1004 0.0650 0.0705 Random 0.0568 0.0583 0.0371 0.0623 0.0485 0.0518 # SD away 9 11 8 19 14 29 P(Vt 1000 5 i=1 V t i = 0) Actual 0.0021 0.0036 0.0025 0.0023 0.0017 0.0022 Random 0.0009 0.0014 0.0015 0.0011 0.0007 0.0010 # SD away 7 7 4 5 7 13 Marti G. Subrahmanyam Informed Options Trading prior to M&A Announcements: Insider Trading? 48 / 50

Is Unusual Options Trading Volume Random? - 2 Equity options are illiquid, there is low volume - exploit zero-volume observations Chance 1 in a million that # with positive volumes greater in pseudo-sample. Empirical Analysis DOTM OTM ATM ITM DITM Full Sample Panel B: Full Sample N 3,411,873 1,428,467 2,380,397 1,428,286 3,412,545 12,061,568 P(Vt > 0) 0.1033 0.2581 0.3487 0.1584 0.0688 0.1668 P(Vt 1000) 0.0022 0.0076 0.0144 0.0034 0.0010 0.0050 Panel C: t [ 5, 1] - Actual vs. Random N 78,424 32,500 27,074 32,540 78,436 248,974 N RS 34,508 15,185 21,066 15,192 34,553 120,504 P(Vt > 0) Actual 0.1155 0.3681 0.4265 0.2408 0.0922 0.1913 Random 0.0982 0.2519 0.3239 0.1502 0.0695 0.1554 # SD away 11 33 32 31 17 34 P(Vt 1000) Actual 0.0038 0.0165 0.0260 0.0067 0.0023 0.0078 Random 0.0016 0.0052 0.0110 0.0024 0.0008 0.0036 # SD away 10 19 21 11 10 24 P(Vt > 0 5 i=1 V t i = 0) Actual 0.0676 0.0799 0.0481 0.1004 0.0650 0.0705 Random 0.0568 0.0583 0.0371 0.0623 0.0485 0.0518 # SD away 9 11 8 19 14 29 P(Vt 1000 5 i=1 V t i = 0) Actual 0.0021 0.0036 0.0025 0.0023 0.0017 0.0022 Random 0.0009 0.0014 0.0015 0.0011 0.0007 0.0010 # SD away 7 7 4 5 7 13 Marti G. Subrahmanyam Informed Options Trading prior to M&A Announcements: Insider Trading? 48 / 50

Liquidity - IV Skewness IV-Skew jumps on Announcement Date. IV-Skew (30-day options) EWlabel 0 5 10 15 IV-Skew (30-day options) EWlabel 0 5 10 15 IVc-delta20 - IVc-delta50.02.025.03.035.015.04.012.014.016.018.02 IVp-delta80 - IVp-delta50 ]...,-30] [-24,-20] [-14,-10] [-4,-1] [1,5] [11,15] [21,25] [31,...[ Event Time (IVp-delta25 - IVc-delta25)/delta50.01.02.03.04.05.06 ]...,-30] [-24,-20] [-14,-10] [-4,-1] [1,5] [11,15] [21,25] [31,...[ Event Time.04.05.06.07.08.09 IVp-delta20 - IVc-delta50 Call-Skew (Mean) Put-Skew (Mean) Call-Skew Random (Mean) Put-Skew Random (Mean) Carr-Wu (Mean) Cremers et al. (Mean) Carr-Wu Random (Mean) Cremers et al. Random (Mean) Flat evolution for randomized pseudo-event dates. Back to Bid-Ask Spreads Marti G. Subrahmanyam Informed Options Trading prior to M&A Announcements: Insider Trading? 49 / 50

SEC Litigation Reports Year SEC LRs Cash ABS Sample Illicit Profits Fines Days to Lit. Moneyness S/K Option Mat. Days to Ann. 1990 1 1. 350,000..... 1993 2 0. 87,593 60,474 1,427.. 20 1994 5 2. 141,456 365,100 953 0.90 1 4 1995 3 0. 377,113 779,102 1,987.. 50 1996 2 2 70 527,500 1,770,000 202 0.93 1 2 1997 4 3 133 185,830 106,341 288 1.02 2 3 1998 7 1 175 339,588 2,128,255 460 0.97 1 7 1999 0 0 217...... 2000 7 3 164 150,996 193,561 1,356 1.09 1 4 2001 2 0 86 300,000. 2,813 0.96 0 0 2002 1 0 36 250,000 61,714 933.. 72 2003 2 1 54 452,871 1,017,857 670 0.91 1 13 2004 2 2 72 1,221,753 5,963,326 497 0.90 1 6 2005 8 2 109 1,478,949 971,151 1,162 0.97 1 18 2006 9 3 119 586,125 827,605 490 0.94 1 10 2007 14 2 159 2,219,556 12,489,449 879 0.92 2 21 2008 5 1 98 595,769 1,223,737 849 0.95 2 15 2009 6 2 74 8,751,193 762,375 1,031 0.87 1 21 2010 11 3 93 409,832 2,830,969 463 0.95 1 19 2011 4 2 114 902,457 324,777 537 0.80 3 21 2012 4 1 86 4,191,446 324,422 91 1.11 1 17 2013 3 2. 3,200,000 500,000 12 0.96 2 4 90-13 5 2. 1,470,056 3,539,593 770 0.94 1 16 96-12 6 2 109 1,567,976 3,770,741 756 0.94 1 16 Back to SEC Litigation Reports Marti G. Subrahmanyam Informed Options Trading prior to M&A Announcements: Insider Trading? 50 / 50